Opinion
Case No. 5:21-cv-01843-JWH-SHKx
2022-04-14
Timothy BRADY, an individual, Plaintiff, v. DELTA ENERGY & COMMUNICATIONS INC., a Delaware corporation; Scott Foster, an individual; John Hendrick, an individual; and Does 1-20, inclusive, Defendants.
H. Troy Romero, Romero Park PS, San Diego, CA, for Plaintiff. Emalee H. LaFuze, Pro Hac Vice, Emily M. Rhine, Pro Hac Vice, Lindsey Pryor, Pro Hac Vice, Manuel G. Berrelez, Pro Hac Vice, Vinson and Elkins LLP, Dallas, TX, Heather Lynn Mayer, Halpern May Ybarra Gelberg LLP, Los Angeles, CA, Michelle K. Arishita, Pro Hac Vice, Vinson and Elkins LLP, Austin, TX, for Defendants Delta Energy & Communications, Inc., Scott Foster, John Hendrick.
H. Troy Romero, Romero Park PS, San Diego, CA, for Plaintiff.
Emalee H. LaFuze, Pro Hac Vice, Emily M. Rhine, Pro Hac Vice, Lindsey Pryor, Pro Hac Vice, Manuel G. Berrelez, Pro Hac Vice, Vinson and Elkins LLP, Dallas, TX, Heather Lynn Mayer, Halpern May Ybarra Gelberg LLP, Los Angeles, CA, Michelle K. Arishita, Pro Hac Vice, Vinson and Elkins LLP, Austin, TX, for Defendants Delta Energy & Communications, Inc., Scott Foster, John Hendrick.
ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS PLAINTIFF'S FIRST AMENDED COMPLAINT [ECF No. 33]
John W. Holcomb, UNITED STATES DISTRICT JUDGE
This dispute arises out of a series of investments gone bad. Before the Court is the motion of Defendants Delta Energy & Communications Inc., Scott Foster, and John Hendrick to dismiss the first amended complaint of Plaintiff Timothy Brady. The Court finds this matter appropriate for resolution without a hearing. See Fed. R. Civ. P. 78 ; L.R. 7-15. After considering the papers filed in support and in opposition, the Court orders that the Motion is GRANTED , as set forth herein.
Defs.’ Mot. to Dismiss First Am. Compl. (the "Motion") [ECF No. 33].
The Court considered the following papers: (1) First Am. Compl. (the "Amended Complaint") [ECF No. 31]; (2) the Motion; (3) Defs.’ Mem. of P. & A. in Supp. of the Motion (the "Memorandum") [ECF No. 32]; (4) Pl.’s Opp'n to the Motion (the "Opposition") [ECF No. 34]; and (5) Def.’s Reply in Supp. of the Motion (the "Reply") [ECF No. 35].
In his Amended Complaint, Brady alleges the facts summarized herein, which the Court assumes to be true for the purposes of this Motion. See, e.g., Cahill v. Liberty Mut. Ins. Co. , 80 F.3d 336, 337-38 (9th Cir. 1996) (on motion to dismiss for failure to state a claim, "[a]ll allegations of material fact are taken as true and construed in the light most favorable to the nonmoving party").
Brady made three investments in Delta, a communications company that claims to have developed a hardware product capable of distributing internet services across wide rural areas through a wireless mesh network system. Brady's first cash infusion in Delta was in the form of a loan for $750,000, which the parties documented on Christmas Eve of 2016. Delta agreed to repay the loan at the earliest of (1) the loan's maturity date of January 2022; (2) the date when Delta raised $4 million in additional financing; or (3) the date of a change of ownership, if such a change occurred.
Amended Complaint ¶ 8.
Id. at ¶ 11.
Id.
A year later, Defendant John Hendrick, Delta's CFO, visited Brady and informed him that Delta would soon be unable to make payroll unless Delta received additional financing. Defendants represented to Brady that a $250,000 loan would serve as a short-term bridge while Delta secured a Series A investment from an investor who was "ready to fund." Delta drafted the $250,000 loan documents as a convertible note. Although Brady was initially opposed to the convertible note instrument, he ultimately agreed to provide the loan under those terms because of the prospect of a Series A investor combined with Delta's promise that it would reimburse Brady for any tax costs that he incurred in connection with the investment. Similar to the $750,000 loan from a year prior, Delta was to repay the $250,000 convertible note at the earliest of the loan's March 2022 maturity date or upon Delta's success in raising $4 million in financing.
Id. at ¶ 12.
Id. at ¶ 13.
Id.
Id.
Id.
In October 2018, Defendant Scott Foster, Delta's CEO, emailed Brady and other investors seeking more funding. In that email, Foster made several false statements, including that Delta had lined up three large customers—the city of Pryor, Oklahoma, and two large utility providers. Foster told Brady that Delta needed $600,000 to launch Delta's first commercial network with those customers. Based upon those representations, Brady agreed to loan Delta another $600,000 pursuant to the terms of a promissory note, which matured in October 2020.
Id. at ¶¶ 15-17.
Id. at ¶¶ 18 & 19.
Id. at ¶ 20.
Delta did not repay any of the loans. Brady alleges, on information and belief, that Delta made numerous representations that were false, including that a Series A investor existed when Defendants asked Brady for the $250,000 bridge loan and that Delta had three potential customers interested in Delta's technology.
Id. at ¶¶ 21 & 22.
Id. at ¶¶ 14 & 23.
Brady commenced this case in November 2021, asserting seven claims for relief:
• fraud in connection with the purchase of securities under Section 10(b) of the Securities Exchange Act of 1934 and its implementing regulation Rule 10b-5;
• fraud in connection with the purchase of a security under Section 12(a)(2) of the Securities Act of 1933;
• violation of Cal. Corp. Code § 25403 ;
• breach of contract with respect to the $250,000 loan;
• breach of contract with respect to the $600,000 loan;
• intentional misrepresentation; and
• negligent misrepresentation.
See generally Compl. (the "Complaint") [ECF No. 1].
Brady amended his complaint in January 2022, adding a claim for breach of contract with respect to the $750,000 loan.
See generally Amended Complaint.
Defendants filed their Motion to dismiss a month later. The matter is fully briefed.
See generally Motion; Memorandum.
See generally Opposition; Reply.
II. LEGAL STANDARD
Defendants move to dismiss Brady's Amended Complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure. A claim should be dismissed under Rule 12(b)(6) when the plaintiff fails to assert a "cognizable legal theory" or the complaint contains "[in]sufficient facts ... to support a cognizable legal theory." Navarro v. Block , 250 F.3d 729, 732 (9th Cir. 2001). To survive a motion to dismiss, the complaint must allege "more than labels and conclusions, and a formulaic recitation of the elements of a cause of action." Bell Atl. Corp. v. Twombly , 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). The claim must be pleaded with "sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face," Ashcroft v. Iqbal , 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009), and that rises "above the speculative level," Twombly , 550 U.S. at 555, 127 S.Ct. 1955. "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Iqbal , 556 U.S. at 678, 129 S.Ct. 1937.
Normally, Rule 12(b)(6) must be read in conjunction with Rule 8(a), see Fed. R. Civ. P. 8(a), which requires a "short and plain statement of the claim showing that a pleader is entitled to relief," in order to give the defendant "fair notice of what the claim is and the grounds upon which it rests." Twombly , 550 U.S. at 555, 127 S.Ct. 1955 ; see also Horosny v. Burlington Coat Factory, Inc. , 2015 WL 12532178, at *3 (C.D. Cal. Oct. 26, 2015). Claims alleging fraud, however, are subject to a heightened pleading standard. See Fed. R. Civ. P. 9(b). Rule 9(b) requires that circumstances constituting a claim for fraud or mistake be pleaded with particularity. Id. That rule requires a plaintiff to "identify the who, what, when, where and how of the misconduct charged" as well as "what is false or misleading about a statement, and why it is false." Ebeid ex rel. United States v. Lungwitz , 616 F.3d 993, 998 (9th Cir. 2010). Additionally, it is well settled in the Ninth Circuit that the Federal Rules of Civil Procedure, including Rule 9(b), apply in federal court, "irrespective of the source of the subject matter jurisdiction, and irrespective of whether the substantive law at issue is state or federal." Kearns v. Ford Motor Co. , 567 F.3d 1120, 1125 (9th Cir. 2009).
III. DISCUSSION
A. Section 10(b) and Rule 10b-5 Claim
Brady's first claim for relief asserts that Defendants violated Rule 10b-5, as promulgated by the Securities and Exchange Commission under Section 10(b) of the Securities Exchange Act of 1934. See 17 C.F.R. § 240.10b-5. The basic elements of a Rule 10b-5 claim are as follows: (1) a material misrepresentation or omission of fact; (2) scienter; (3) a connection with the purchase or sale of a security; (4) transaction and loss causation; and (5) economic loss. See In re Daou Sys., Inc. , 411 F.3d 1006, 1014 (9th Cir. 2005) (citing Dura Pharms., Inc. v. Broudo , 544 U.S. 336, 341-42, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005) ).
Amended Complaint ¶¶ 26-35.
Claims brought under Rule 10b-5 and Section 10(b) must meet the particularity requirements of Rule 9(b). Id. ; see also Fed. R. Civ. P. 9(b). Furthermore, the enactment of the Private Securities Litigation Reform Act ("PSLRA") in 1995 significantly altered the pleading requirements in private securities fraud litigation by amending the 1934 Exchange Act to require a complaint to "plead with particularity both falsity and scienter." Ronconi v. Larkin , 253 F.3d 423, 429 (9th Cir. 2001).
Brady's allegations generally fail to meet those stringent pleading requirements with respect to the first and second elements of his Rule 10b-5 claim. Accordingly, the Court does not reach the remaining three elements.
1. Falsity
In his Amended Complaint, Brady identifies 10 alleged misrepresentations. Nevertheless, Defendants argue that Brady pleads no facts demonstrating the reason why those statements are allegedly false. For the most part, Defendants have it right.
Id. at ¶ 28.
Memorandum 10:12-12:7; Reply 2:19-3:23.
Under the PSLRA, Brady must "specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading." Tellabs, Inc. v. Makor Issues & Rts., Ltd. , 551 U.S. 308, 321, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007) (citing 15 U.S.C. § 78u–4(b)(1) ). Brady does not meet this standard for most of his allegations. Nothing in the Amended Complaint, for example, corroborates his allegation that the city of Pryor was not in the final stages of negotiations with Delta; nothing identifies what misleading statements were made about the various loans; no facts or reasons are given to explain why $600,000 would not have allowed Delta to complete the demonstration in Pryor; nothing identifies which statements were made about Delta's intellectual property, capabilities, human resources, and equipment (or who made those statements).
Amended Complaint ¶ 28.
Brady's only two allegations that come close to meeting that standard are:
• Defendants’ statements regarding the Series A investor were misleading because—per Brady's allegation on information and belief—the Series A investor did not exist; and
• Delta omitted the fact that it had the capability to repay the loans because—again per Brady's allegation on information and belief—Delta had already raised $4 million of additional financing.
Id. at ¶ 14.
But each of those two allegations fails for a different reason.
The first falls short because the Amended Complaint does not identify who made those allegedly misleading statements regarding the Series A investor. Brady merely avers statements made by "Defendants." That broad allegation constitutes impermissible group pleading. Generally speaking, " Rule 9(b) does not allow a complaint to merely lump multiple defendants together but requires plaintiffs to differentiate their allegations when suing more than one defendant and inform each defendant separately of the allegations surrounding his alleged participation in the fraud." United States v. Corinthian Colleges , 655 F.3d 984, 997–98 (9th Cir. 2011) (internal citation omitted). Furthermore, with the enactment of the PSLRA, courts around the country and in this district have emphatically rejected the use of group pleading for Rule 10b-5 claims. See In re New Century , 588 F. Supp. 2d 1206, 1223–24 (C.D. Cal. 2008) ("All of the Circuit courts that have expressly considered whether group pleading is compatible with PSLRA have concluded that it is not."); Petrie v. Elec. Game Card Inc. , 2011 WL 165402, at *3 (C.D. Cal. Jan. 12, 2011) (observing that "[t]he Central District of California, in particular, appears to be unanimous in this conclusion; neither Plaintiffs nor the Court have uncovered any post- Tellabs within-district case law holding to the contrary" and holding that it "joins the chorus of voices rejecting the continued viability of the group pleading doctrine"). Because Brady does not identify who specifically made those statements, the Court finds his allegations insufficient to withstand Defendants’ Rule 12(b)(6) attack.
See id. at ¶¶ 13 & 54.
The second of Brady's potentially viable allegations—Delta's supposed omission of the fact that it had raised $4 million in additional financing—also fails because it is unclear whether that alleged fact was true at the time that the relevant contract was signed. Indeed, this issue of timing is endemic to all of Brady's allegations, as he does not plead specific facts showing that Defendants’ statements were false or misleading, known to be false or misleading, or made on an unreasonable basis at the time that they were made . "A statement can constitute a material misrepresentation giving rise to Section 10(b) or Rule 10b-5 liability if there is no reasonable basis for the speaker's belief in the statement's accuracy or if the speaker is aware of undisclosed facts tending seriously to undermine the statement's accuracy." In re Oracle Corp. Sec. Litig. , 627 F.3d 376, 390 (9th Cir. 2010). But it matters whether Defendants "lacked at least a reasonable basis" for any given statement or representation " when it was made." Id. (emphasis added). Here, Brady's Amended Complaint is devoid of factual allegations that could show that Defendants’ statements or representations were not made in good faith at the time that they were made. What Brady does allege pertaining to timing is simply too conclusory. Even if one could infer that Delta's business transactions did not always pan out in the way that any of the parties hoped, being "incorrect in hindsight" does not make Defendants’ statements "untrue when made." Id.
Id. at ¶¶ 14, 23, 28, 54, & 55.
See generally id.
See, e.g., id. at ¶¶ 14 & 23.
In sum, Brady's allegations do not meet the heightened pleading standard with respect to the first element of a claim arising under Rule 10b-5.
The Court disregards the new allegations that Brady makes in his Opposition, such as the idea that the technology did not actually work, see Opposition 11:22, because "[r]eview is limited to the complaint." Cervantes v. City of San Diego , 5 F.3d 1273, 1274 (9th Cir. 1993).
2. Scienter
Brady also falls short with his allegations regarding scienter, the second element of a claim under Rule 10b-5. The Supreme Court has explained that:
Setting a uniform pleading standard for § 10(b) actions was among Congress’ objectives when it enacted the PSLRA.... Under the PSLRA's heightened pleading instructions, any private securities complaint alleging that the defendant made a false or misleading statement must ... "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind," § 78u–4(b)(2).
Tellabs, Inc. , 551 U.S. at 320–21, 127 S.Ct. 2499. A plaintiff must plead sufficiently particular facts to draw "cogent and compelling" inferences of scienter. Id. at 324, 127 S.Ct. 2499.
Even when viewing the Amended Complaint in its entirety and taking all of its allegations as true, the Court does not find a cogent or compelling inference of scienter. For instance, notably absent are any facts showing that Delta did not intend to uphold its contractual arrangements or that Foster knew that his statements about Delta's business prospects were false. At most, Brady states in a conclusory manner that Defendants made those statements with fraudulent intent and then points to the allegation that Delta has not repaid its loans to Brady. Breaching a contract, however, is not ipso facto evidence of securities fraud. See Reese v. BP Expl. (Alaska) Inc. , 643 F.3d 681, 692 (9th Cir. 2011) (reiterating that a "contract breach is not a sufficient predicate for securities fraud").
Amended Complaint ¶¶ 16, 22, 23, & 29; Opposition 13:25-14:9. Brady also invites the Court to consider exhibits submitted by Defendants, which are outside the scope of the pleadings. See Opposition 9:16-22. The Court declines to do so, as that would convert the instant Motion into one for summary judgment. Fed. R. Civ. P. 12(d). It appears that this case is not yet ripe for summary judgment, given that discovery is still in its early stages. See Opposition 11:1 (opining that "discovery will be needed").
Moreover, "a court must consider plausible, nonculpable explanations for the defendant's conduct" when determining whether to dismiss a complaint under Rule 10b-5. Tellabs, Inc. , 551 U.S. at 324, 127 S.Ct. 2499. Brady insists that Defendants "never identified past investors and never entered into contract with the purported prospective clients" that they mentioned. But even if that is true, Defendants’ omissions or inactions hardly make Brady's case open-and-shut. Plausible alternatives abound. For instance, it is possible that the putative Series A funder backed out after Brady made his initial loan and, therefore, would not have—nor could have—been identified an investor. Perhaps Foster misgauged the readiness of those three potential customers to sign a contract, notwithstanding promising discussions or other signals. Delta may have had every intention to pay back its loans to Brady by their respective maturity dates, but it may have failed to perform simply because it was cash strapped. The prospect that business does not go quite as planned is hardly unusual for an early-stage start-up company. Thus, the Amended Complaint does not meet the second element for a claim under Rule 10b-5.
Opposition 14:3-6.
In view of those shortcomings on the first two elements, the Court finds it appropriate to GRANT the Motion and to dismiss Brady's first claim for relief with leave to amend .
B. Section 12(a)(2) Claim
Brady's second claim for relief seeks remedies for Defendants’ alleged fraud in connection with the purchase of a security under Section 12(a)(2) of the Securities Act of 1933. To prevail on such a claim, "a plaintiff must demonstrate (1) an offer or sale of a security; (2) by the use of a means or instrumentality of interstate commerce; (3) by means of a prospectus or oral communication; (4) that includes an untrue statement of material fact or omits to state a material fact that is necessary to make the statements not misleading." Miller v. Thane Int'l, Inc. , 519 F.3d 879, 885 (9th Cir. 2008) ; see also 15 U.S.C. § 77l (a)(2).
Amended Complaint ¶¶ 36-43.
Defendants argue that Brady's second claim is time-barred. The Court agrees. "In no event shall any such action be brought to enforce a liability created ... under section 77l(a)(2) of this title more than three years after the sale ." 15 U.S.C. § 77m (emphasis added). The Amended Complaint alleges that the parties executed the most recent loan on October 8, 2018. Brady did not file his Complaint until November 1, 2021. Therefore, more than three years elapsed between the sale of the most recent security and the commencement of this case, rendering Brady's second claim for relief time barred. See Stichting Pensioenfonds ABP v. Countrywide Fin. Corp. , 802 F. Supp. 2d 1125, 1130 (C.D. Cal. 2011) (holding that 15 U.S.C. § 77m barred the plaintiff's securities claims based upon alleged misrepresentations when the original complaint was filed more than three years after the investor bought the mortgage-backed securities at issue). Thus, even if Brady amended his pleading and cured any deficiencies with respect to his allegations of misrepresentations, see supra Part III.A.1., the Court still could not entertain this claim for relief, unless Brady can allege that Defendants sold him a security on November 1, 2018, or thereafter. The Court therefore GRANTS the Motion and dismisses Brady's second claim for relief, but, again, with leave to amend .
Memorandum 18:1-4.
Amended Complaint ¶ 20.
See generally Complaint.
C. State Law Claims
Defendants raise reasonable doubts whether the Court possesses subject matter jurisdiction over the remaining six state law claims. With Brady's Rule 10b-5 claim and Section 12(a)(2) claim dismissed, Defendants contend that the only basis for jurisdiction that remains is supplemental jurisdiction. See 28 U.S.C. § 1367(a). Brady responds, in part, by contending that subject matter jurisdiction exists based upon diversity of citizenship. But neither the Complaint nor the Amended Complaint alleges diversity jurisdiction. Furthermore, the pleadings only add to the confusion, since Brady says he resides in Idaho, but he appears to own (or to have owned) a home in California and to have resided here during the events leading up to this case.
Memorandum 19:11-16. Defendants further argue that this Court should not extend supplemental jurisdiction. Id. at 3:4-5.
Opposition 23:8-20.
See generally Complaint; Amended Complaint.
Compare Amended Complaint ¶ 1 with id. at ¶ 12 ("Hendrick, Delta's CFO, visited Brady at his home in Palm Desert, California") and id. at ¶ 51 ("Defendants made the Representations to Brady while he resided in California").
"Federal courts are courts of limited jurisdiction." Kokkonen v. Guardian Life Ins. Co. of Am. , 511 U.S. 375, 377, 114 S.Ct. 1673, 128 L.Ed.2d 391 (1994). The Court will not manufacture diversity jurisdiction when the parties do not clearly allege it, since the burden of establishing jurisdiction rests upon the party asserting it. See id. ; see also Fed. R. Civ. P. 8(a)(1) (noting that pleadings " must contain" a short and plain statement "of the grounds for the court's jurisdiction") (emphasis added). Furthermore, the Court declines to exercise supplemental jurisdiction when it has dismissed Brady's federal claims. See 28 U.S.C. § 1367(c)(3). Thus, the Motion is GRANTED and Brady's remaining state law claims are dismissed for lack of subject matter jurisdiction . But the Court will likewise grant Brady leave amend to clarify any basis of jurisdiction.
IV. CONCLUSION
For the foregoing reasons, the Court hereby ORDERS as follows:
1. Defendants’ instant Motion to dismiss is GRANTED . Brady's Amended Complaint is DISMISSED with leave to amend .
2. Brady is DIRECTED to file an amended pleading, if at all, no later than April 29, 2022. If Brady chooses to file an amended pleading, then:
a. Brady is also DIRECTED to file contemporaneously therewith a Notice of Revisions to First Amended Complaint that provides the Court with a redline version that shows the amendments; and
b. Defendants are DIRECTED to file their response to Brady's amended pleading no later than May 13, 2022.
3. If Brady fails to file his amended pleading by April 29, 2022, then the Court will DISMISS this action with prejudice .